In our ongoing analysis of the global investment landscape and assessment of risks and opportunities, we typically focus our attention on global monetary and credit conditions, allowing politics to take a back seat. This year has been a departure from that framework to some extent, as the rise of populism in the US and Europe has created a unique set of risks and opportunities, which we discussed in our June edition of Markets in Motion and in our recent Topical Webinar.
Markets got their first taste of the potential impact of these ascendant political forces when the British electorate voted on June 23 in favor of withdrawing from the European Union. How the UK and the EU will ultimately negotiate their divorce remains to be seen, but we expect it will be more amicable than the market reaction suggests. British and EU politicians understand the importance of trade, and will make it their priority to enable the UK to remain a member of the European Economic Area (EEA). The biggest hurdle in these negotiations will be the EEA’s insistence on the free movement of labor, which under current law cannot be curtailed while maintaining free movement of goods, services, and capital. British sentiment towards immigration will be important to monitor as negotiations develop in the next couple years, with pro-Brexit politicians already backpedaling as they face the economic realities of their proposal.
Financial news networks have not taken such a level-headed view. Fears of contagion abound, with rampant speculation that Brexit paves the way for other countries to withdraw from the EU, possibly leading to the erection of trade barriers with major negative economic consequences. Additionally, some commentators view the event as a catalyst for the reemergence of the European banking crisis. We agree that these are significant risks, European policymakers have proven to be prudent and pragmatic, and we expect Brexit will be manageable without major unintended consequences, though there will likely be periods of market volatility as the path forward becomes clearer.
Price action in the weeks following the historic vote reflects the panicked commentary. The British Pound sold off by more than 20 cents from $1.50 to under $1.30. The Euro sold off a small amount in sympathy, and the ongoing rally in the Yen intensified as investors sought its “safe haven” status. Equity markets sold off initially, but have rebounded in hope of additional central bank accommodation to counteract the negative economic effects of Brexit. Gold has rallied as a result of both its “safe haven” status and the prospect of more central bank easing. But the most notable reaction has been in the bond market. 10yr UST yields have fallen from 1.74% to as low as 1.34%, and the global stock of bonds with negative yields has increased to greater the $13 trillion. Unbelievably, the Swiss 50yr sovereign bond now carries a negative yield. Our portfolios were well positioned with significant exposure to gold and long duration fixed income, and our flagship Global Tactical Allocation portfolio finished the month of June up +2.94%.
Overall, our GTA portfolio holds 47% fixed income, 18% US equities, 28% international equities, 5% alternatives, and 2% cash. Our fixed income holdings focus on high quality issues, longer duration, and are globally diversified. Our equity holdings are also globally diversified and our international equity exposure is not currency-hedged, enabling us to benefit from a weaker US dollar.
Our fixed income allocation provides us with diversification through positions in long-duration US treasuries, investment grade corporate bonds, preferred stock, foreign currency-denominated international high yield bonds, and dollar-denominated emerging market debt. Our position in long-duration US treasuries has been particularly strong for us in the wake of the Brexit vote, having returned 7.7% since the vote and 21.5% since we initiated the position in November 2015.
Our US equity exposure is focused on conservative companies and sectors. We hold positions in low volatility equities and high dividend paying equities. This increases our relative exposure to companies with stable earnings, helping us navigate a volatile policy environment.
We hold a large position in low volatility equities across Europe, Australia, and Asia (EAFE), which we have recently increased. This gives us exposure to companies with stable earnings, providing safety and lower volatility in an uncertain policy environment. In the past 6 months, our low volatility EAFE equity position has outperformed the broader EAFE market by more than 5%.
Following the Brexit vote, European financials sold off sharply. We believe that the risks driving this selloff, while serious, will be resolved positively. We have therefore taken a small position in European financials. European banks will benefit from policy support in the second half of the year, and are also supported by their deep value and a dividend yield greater than 5%.
Following the major rebound in commodities and commodity-sensitive assets, we have sold our position in Canadian equities for a profit of more than 17%. While we still view Canada in a positive light, the European selloff following the Brexit vote created a much more attractive opportunity across the Atlantic. We have therefore decided to allocate capital away from Canada and into Europe.
We hold a position in Australian equities. This gives us exposure to commodity-sensitive assets, while avoiding oil-sensitive exposure to a large extent. Additionally, the Australian government has announced substantial fiscal stimulus plans to boost its domestic economy, which will support domestic demand and corporate earnings.
After years of underperformance, emerging market equities represent good relative value, and investor sentiment has improved. We therefore own a position in emerging market low volatility equities. By allocating to low volatility equities, we are targeting conservative companies with stable earnings, and avoiding cyclical companies and sectors.
We continue to hold a position in gold, which is supported by low interest rates, elevated volatility, and an uncertain policy environment. Additionally, as an asset with low correlations to most others, it lowers overall portfolio volatility.
*Some Emerging Markets allocation overlaps with regional allocations.
^Excluding GTA’s 54% fixed income, alternative, and cash positions.
**Individual account allocations may differ slightly from model allocations.
Past performance is no guarantee of future results. The material contained herein as well as any attachments is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies, opportunities and, on occasion, summary reviews on various portfolio performances. Returns can vary dramatically in separately managed accounts as such factors as point of entry, style range and varying execution costs at different broker/dealers can play a role. The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts are inherently limited and should not be relied upon as an indicator of future results. There is no guarantee that these investment strategies will work under all market conditions, and each advisor should evaluate their ability to invest client funds for the long-term, especially during periods of downturn in the market.
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